Wednesday, April 4, 2018

CorePoint Lodging: Form 10 Notes

Today I'm doing another update, this time on La Quinta's upcoming REIT spinoff, CorePoint Lodging (CPLG), based on the long awaited update (at least on my part) to their Form 10 and the merger agreement between La Quinta (LQ) and Wyndham Worldwide (WYN).  Quick recap, La Quinta announced last year their intention to separate the hotel management business from the real estate, initially that was a straight forward spinoff of the real estate into a REIT, but Wyndham came along and offered to buy the management company for $1.95B in cash.  Later in Q2, La Quinta shareholders will receive $8.40 per share from Wyndham for the management company and shares in the REIT spinoff, CPLG.

The setup for CPLG checks off a lot of boxes, it's likely to sold/trade cheaply as a taxable spinoff, plus it will have the dual benefits of EBITDA growth and a multiple that needs to come up.  When I've gotten in trouble with spinoffs or just special situations in general, its usually because the spinoff is a dressed up melting ice cube, I believe the opposite is true in CorePoint's case.

CorePoint will have 317 hotels with over 41,000 rooms across the United States (all of LQ's international hotels are franchised or managed) and is positioning itself as the "only public REIT focused on the midscale and upper midscale self-service lodging segment."  That's more happenstance than design, but self-service hotels feature more consistent and wider margins than their equivalent segment full-service competitors (fewer employees, 99% of revenues from room rentals).  On the negative side select-service hotels are viewed as easier to build, CorePoint pointed to the fact that midscale hotels are the fastest new build segment (its pitched as a positive), that's good for Wyndham has a management company but likely bad for operators like CorePoint as more suppy comes onto the market.  The majority of their hotels are located near suburban office parks, airports and along interstates, mostly avoiding urban and resort locations that could be more impacted by AirBnB and HomeAway like room sharing services (but again, easier to build new supply in suburban locations).  As a REIT, CorePoint technically can't operate the hotels under the typical franchise arrangement Wyndham uses and instead the hotels will be managed by Wyndham for a 5% of revenue fee (plus your typical royalty, reservation, and marketing fees you'd see in a franchise arrangement).

Quick screen shots from the Form 10, listing the locations and chain scale, much of the economy bucket is exterior corridor hotels that they've been selling off in recent years, but as you can see, a reasonably diversified hotel base for a one brand REIT.
At the time of my brief post on the idea in January, we didn't know the proforma capital structure at CorePoint and it muddied up the valuation a bit.  CorePoint is taking out $1.035B of CMBS financing that is secured by their hotel properties and then paying a dividend to LQ/WYN of $983.95MM subject to the adjustments listed below from the Separation and Distribution Agreement:
Section 3.6. Cash Payment. Upon the completion of the Financing Transactions and immediately prior to the Effective Time, CPLG shall transfer to LQ Parent or the applicable member of the LQ Parent Group, as directed by LQ Parent, an amount equal to $983,950,000, as such amount may be adjusted pursuant to this Section 3.6, such amount of which will, substantially concurrently with the Distribution and the Merger, be used by LQ Parent to satisfy a portion of the Liabilities outstanding under the Existing Debt Agreements; provided that:
(a) in the event the Closing Existing Net Indebtedness exceeds the Estimated Existing Net Indebtedness, the Cash Payment shall be increased on a dollar-for-dollar basis by the amount of such difference;
(b) in the event the Estimated Existing Net Indebtedness exceeds the Closing Existing Net Indebtedness, the Cash Payment shall be decreased on a dollar-for-dollar basis by the amount of such difference;
(c) in the event the amount of accrued but unpaid Transaction Expenses as of the Distribution Date exceeds the Estimated Transaction Expenses, the Cash Payment shall be increased on a dollar-for-dollar basis by the amount of such difference; and
(d) in the event the Estimated Transaction Expenses exceed the amount of accrued but unpaid Transaction Expenses as of the Distribution Date, the Cash Payment shall be decreased on a dollar-for-dollar basis by the amount of such difference.
The Estimated Existing Net Indebtness is listed as $1.665B in the agreement, as of 12/31/2017, LQ had net debt of $1.53B, reducing CPLG dividend payment down to ~$850MM.  The cash position at the time of the spinoff will then be something in neighborhood of ~$185MM ($1.035B - $850MM).  Proforma CorePoint earned $208MM in (adjusted) EBITDA for 2017, using my previous 12x multiple, gets me to about $14/share for CPLG.
$14 + $8.40 from WYN when the deal closes, gets you to $22.40 per share, or put another way, the market is currently valuing CPLG at a little under 10x EBITDA (no internally managed lodging REIT trades that cheap) at today's $18.84 share price.

Sources of Upside:
  • The cash balance will likely be higher than $185MM, we should assume some additional cash build from the beginning of the year until the deal closes (although maybe not due to rebuilding efforts after the hurricanes).  Plus as part of the Tax Matters Agreement, CPLG will receive any excess between the actual tax due and the $240MM amount Wyndham agreed to escrow as part of the management company deal.  I can't quite figure out what the cost basis is for LQ itself (I saw an analyst note that pegged it at $1.7B but can't source it for myself) so if you know what the amount is, please let me know.  Let's say that $1.7B is correct and my EV on the first day is correct at $2.5B, the Tax Matters Agreement assumes the tax rate at 24.65%, which would be about ~$200MM of the gain, meaning $40MM could come back to CPLG and potentially more if really trades down day 1 (most likely as I doubt it'll trade at 12x EBITDA to start).
  • This will also be taxable for shareholders, your taxable gain will be $8.40 + CPLG's first day price over your own tax basis, so all current LQ shareholders (including 30% owner Blackstone) should be cheering for the shares to get dumped the first day and then hopefully recover once the proforma numbers are clearer.
  • The spinoff is maybe ~2 months out and we don't have a CorePoint specific shareholder presentation, I haven't seen a lender presentation (which makes sense since they went the CMBS route) or heard about a road show, maybe there has been one but its certainly under the radar, it seems pretty clear to me that management isn't going to try and pump the stock up ahead of time.
  • This is quite the interesting dynamic where the lower the price, the better for everyone involved, management appears to know this and hasn't put out any forward guidance for the spinoff leaving the market to anchor to 2017's numbers.  2017's numbers could be deceptively low for three reasons: 
    1. The 2017 hurricanes significantly impacted La Quinta's owned hotels in Florida and Texas, in Florida more than 3000 rooms were out of service for the last four months of the year, and as of 2/28, 5% of CPLG's rooms remain out of service as they undergo repairs.  They disclosed a $36.7MM revenue impact due to Hurricane Irma closures in 2017, and on the Q4 call translated this into an annualized estimated EBITDA loss of $28-35MM (to be recouped through insurance proceeds which should add to the cash balance as well).  This could be a short term risk to the stock price depending on how quickly their Florida hotels get back online, but eventually the insurance proceeds will come in and the hotels will reopen.
    2. LQ initiated a big capex program in late 2016, they identified 50 hotels to renovate with the hope to move them from midscale to upper-midscale and capture greater room rates.  With this renovation project, many hotel rooms were out service and are just now re-opening, the renovation project cost $180MM and is expected to be largely complete by the time of the spinoff, what return will that investment make going forward?  On the Q4 conference call, managemend stated that remodeled hotels had on average a 13% increase in RevPAR upon reopening.
    3. La Quinta has always been a standalone brand without a larger rewards group.  La Quinta Rewards has 15 million members, by joining Wyndham Rewards and their 55 million members, WYN will funnel more travelers to CorePoint's properties.  They'll also potentially see some margin benefits from shifting a few percentage points away from OTA's to their direct reservation sites being part of Wyndham.  Additionally, there could be some opportunity to rebrand some of CorePoint's La Quinta hotels that are upscale or on the high end of the upper mid-scale segment to one of Wyndham's upscale brands.
  • Let's pretend forward EBITDA is closer to $235MM for 2019 (hurricane recovery, renovated hotels coming back online at higher rates and WYN synergies) CorePoint could be worth over $16 per share, or over 50% upside from today's implied price.
Other Thoughts:
  • I've received some pushback on this idea due to the "one brand" risk, however with a hotel REIT, I think some of that risk is overblown.  CPLG as a hotel REIT is not taking the credit risk of LQ/WYN unlike some of the triple-net lease REITs that were spun off with one master lease tenant.  Hotels change the logo on the outside of the building not infrequently; brand diversification makes for a nice investor relations slide but how important is it really?  Quick service restaurant franchisees usually specialize in one brand, although Papa Johns franchisees maybe wished they also own Dominos stores, I think of the hotel REIT business similarly, more about locations, markets and value/price over single brand risk.
  • CorePoint will have geographic market concentration risk, 23% of their hotel rooms are in Texas which caused the stock to drop significantly during the oil downturn in 2014-2015, and more recently their concentration in Florida resulted in significant disruption after Hurricane Irma.  Mr. Brightside, both markets are recovering and should provide a tailwind to CorePoint's results post spinoff.
  • There will be a 1 for 2 reverse split ahead of the transaction, keep that in mind when it actually starts trading, my $14 estimate becomes $28.  In the Form 10, a purging dividend is mentioned but its expected to be minimal.
  • CorePoint mentions they intend to be an acquirer, initially that seemed strange, but given the potential cash position at the spinoff, it might make sense to play consolidator for a minute in the fragmented midscale segment (another source of growth).  Either way, with the spinoff being taxable and the presence of a 30% private equity owner, I'd expect CorePoint to be acquired in relatively short order (6-24 months) after the spinoff.
It might be better to wait for the spinoff to occur and get some more color around the Florida hotel recovery speed before diving in but I have a position now and expect to add to CPLG when it begins trading.

Disclosure: I own shares of LQ and WYN (plus WYN calls)

8 comments:

  1. Your 2nd paragraph on melting ice cubes: you can apply the classic "Munger helped Buffett see the virtue of quality" to spinoffs. Hilton Grand Vacations(HGV), best-in-class, high ROIC, 25 yrs of uninterrupted growth, was never written up on VIC. I wonder why. My guess is over-focus on cheapness over quality. For spinoff investors, HGV has been very satisfactory so far.

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    1. Yes, I liked HGV from the spinoff and its seen significant multiple expansion, I made some money off of it, but should have owned more, think we might see a smaller version of that with WYN soon.

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  2. MDC which call strike/expiry. Thanks

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    1. For WYN, I own the $115 Aug calls.

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  3. Hi, thanks for your notes. How does the spin off being taxable and the 30% PE ownership make CP a more attractive takeover target? Thanks!

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    1. Since its taxable, there is no two year safe harbor period on the tax-free aspect of a typical spinoff, usually companies wait two years (if you don't, there's a hurdle involved to prove you weren't in talks prior to the spinoff). Then with Blackstone, pure speculation on my part, but they'll already be taking a capital gain in 2018 due to the spinoff, they're not forever long term holders, they could do a secondary and get out like HNA has been doing with HLT/HGV/PK but I'm guessing Blackstone could get a better price in a takeover scenario since I doubt CPLG trades at a significant premium.

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  4. First of all, thank you for all your fantastic insight on this blog. You’ve opened my eyes to how to do great analysis for special situations.

    Just curious, if you only had a bit of extra cash to invest, would you prefer owning La Quinta or Wyndham before the spinoffs?

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    1. Thanks for the kind words. If I had to choose I'd probably own WYN before the spinoff as with LQ you're receiving a fixed amount of $8.40/share for the management company, but I can envision a scenario where CPLG sells off and creates a great opportunity after the spinoff.

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